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The Dead Hand Journal

Journal

With our Secretaries of State and Treasury both off in Beijing kissing all the ChiCom butt they can manage, Mr. Smith tipped me off to a piece by Jason Steck over at The Compass on the interconnected nature of the U.S. and Chinese economies. Smith himself had a thing or two to say, concluding with this:

The situation cannot continue indefinitely, with the US debt skyrocketing.

Okay, I'll bite...

You have to look at both sides of the equation!

There are only three ways Government can acquire a dollar to spend: it can take it away from the people (direct taxation), borrow it from somebody (debt), or print it (inflation).

Consider our economy as a pool of capital. Left to its own devices in a free society, this pool of capital will grow. This is a fundamental tenet of capitalism, and the mechanism of this growth is production, which is effectively the expenditure of energy to decrease the level of entropy--or, if you prefer, to INCREASE the level of organization--within the economy.

Any form of tax--whether direct taxation, debt service, or inflation--introduces friction into the equation. Taxes siphon off capital and reduce the pace of growth. Without getting into the details of how many dollars the government spends and for what, it's fair to point out that--ideally--a given dollar spent by Government should introduce as little friction as possible into the system.

So here's some hand-wavy math.

The highest-friction kind of taxation is inflation, because its entire effect is instantaneous: print a dollar, and you have instantly increased the cost of EVERY transaction and reduced the value of EVERY asset, globally and at once.

Direct taxes remove value from the economy on a quarterly basis, meaning that a given dollar can keep on generating production for up to three months before it is removed from circulation. Plus, it's never completely gone, since most dollars taxed are ultimately returned to some other place in the economy. The main problen with direct taxation is that the dollars usually start in a place where they generate LOTS of production and wind up in a place where they generate almost none at all. So, while the effect of inflation is to destroy the value that FEEDS production, the effect of direct taxation is to reduce the productive IMPACT of the average dollar.

Debt is interesting.

When Government borrows a dollar--all other things being equal--that dollar is NOT taxed, not directly. It is thus left in the economy to drive production. Whether or not this is an advantage depends on the difference between the long-term value produced by that dollar and all its children, and the long-term cost of servicing the debt. If the difference is a positive number, then the overall economy has benefited from the decision to borrow instead of tax. When you consider that the typical Treasury security takes decades to mature, even a small advantage can compound hugely.

So, if you work the numbers, it turns out that--even in the current economic slump--debt is manifestly our friend. Something really fundamental would have to change in our economy before direct taxation would become a better option than borrowing. The caveat, of course, is that the economy HAS to keep growing, or the debt WILL eat us alive. That's the bad news.

Now, technology is a production multiplier. It is, in fact, the ONLY production multiplier! Asserting that economic growth will come to an end is fundamentally equivalent to asserting that technological growth will come to an end... that we will reach the end of innovation.

Now, I'm not saying that there are no physical limits to innovation. What I AM saying, though--and this is the good news--is that there are so many orders of magnitude between our current technology and those theoretical limits that it really doesn't even make much sense to talk about them within our current context. Within our current economic context, the only REAL limits to the growth of production are not technological, but POLITICAL.

So what's the moral of the story? Worrying about our debt to China is completely putting the cart before the ox, because creating new debt is actually by far the most cost-effective way to fund Government, SO LONG AS OUR ECONOMY CONTINUES TO GROW.

Policies that damage economic growth don't just hurt us in the short term... by closing the gap between the cost of taxation and the cost of debt, they invalidate the most efficient mechanism we know of for producing that growth in the first place!

It's a big confidence game. "We" are essentially stealing. We borrow the money, we distort figures to maintain the fiction that "OUR ECONOMY CONTINUES TO GROW".How is this pattern expected to differ from a banana republic doing the same? Do we think ourselves too big to fail?After about one major natural disaster, the nakedness will be laid bare.

The question of whether funding the government is an act of theft is a philosophical one. The answer certainly depends at least in part on what you're funding Government FOR, but if it's theft at all, then it's EQUALLY theft whether you tax, borrow, or inflate.

If your point is that debt is theft from FUTURE generations, then what about the loss of future production caused by the extraction of directly taxed dollars from the economy today? There's no such thing as a free lunch, and ALL present actions have future consequences.

Re. banana republics... The fact of the matter is that NO banana republic can borrow money at a low enough rate to perform the arbitrage I described. Who would take the risk of lending it to them? Our debt load is both the consequence and a proximate CAUSE of our economic strength.

Gov't prints money. This fiat currency is a faith based debt of the gov't (used to be you could exchange for gold...alas, no more). Then there is gov't borrowing (T-bills, T-bonds, etc.): this creates more debt (don't forget the other side of the coin, credit: someone extended credit to Uncle Sugar when they bought his promise to pay). Additional credit is created by the fractional reserve banking system (for each dollar of deposits, a bank can lend out $133: think about that for a moment). Add in the willingness of other countries to extend credit to Uncle Sugar due to perceived stability and reliability and you have massive amounts of credit available. Don't forget that all of that easy credit is looking for an outlet, which it finds in both investments in capital goods that market forces would have encouraged investment in anyway and investment in capital goods that would not have occurred but for the easy credit. Throw in a healthy dose of gov't interference in markets by favoring certain players/areas and disfavoring others. What you end up with is a recipe for boom/bust cycles due to easy credit and the resultant malinvestment. For the icing on the cake, don't forget a monetary policy that relies upon easy credit to encourage a successive malinvestment boom to drag us out of the last bust and a bunch of keynesian economists that keep telling politicians that they can tax/print/borrow more money to cure the problem through gov't spending ("Have another round, sailor. You can drink yourself sober.") and you have a real disaster of a downward spiral that can only end in a complete disaster.